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Rate Rage

September 19, 2015 1:51 pmSeptember 19, 2015 1:51 pm

Photo

Credit Salon.com

OK, I should have seen that one coming, but didn’t: the banking industry has responded to the Fed’s decision not to hike rates with a primal cry of rage. And that, I think, tells us what we need to know
about the political economy of permahawkery.

The truth is, I’ve been getting this one wrong. I’ve tried to understand demands that rates go up despite the absence of inflation pressure in terms of broad class interests. And the trouble is that it’s
not at all clear where these interests lie. The wealthy get a lot of interest income, which means that they are hurt by low rates; but they also own a lot of assets, whose prices go up when monetary policy is easy.
You can try to figure out the net effect, but what matters for the politics is perception, and that’s surely murky.

But what we should be doing, I now realize, is focusing not on broad classes but on very specific business interests. In particular, commercial bankers really dislike a very low interest rate environment, because it’s
hard for them to make profits: there’s a lower bound on the interest rates they can offer, and if lending rates are low that
compresses their spread. So bankers keep demanding higher rates, and inventing stories about why that would make sense despite
low inflation.

Now, you can argue, as Brad DeLong does, that easy money is in the long-run interest of commercial banks
— that in the end the nominal interest rate depends on the rate of inflation, and that locking us into a lowflation or deflation world would be very bad for the banks. But nobody has ever accused bankers
of being especially clear about macroeconomics, and in any case what matters for today’s bank executives is not the long run but the next few years, during which they either will or won’t be getting
big bonuses; in the long run they are all full-time golfers.

So the demand for higher rates is coming from a narrow business interest group, not the one percent in general. But it’s an interest group that has a lot of clout among central bankers, because these are people
they see every day — and in many cases are people they will become once they go through the revolving door. I doubt there’s much crude corruption going on at this level (or am I naive?), but officials
at public monetary institutions — certainly the BIS, but also the Fed — are constantly holding meetings with, having lunch with, commercial bankers who have a personal stake in seeing rates go up no
matter what the macro situation.

Like everyone, the bankers no doubt are able to persuade themselves that what’s good for them is good for America and the world; more alarmingly, they may be able to persuade officials who should know better.
Does this explain the puzzling divergence between the views of Fed officials and those of outsiders like Larry Summers (and yours truly) who have a similar model of how the world works, but are horrified by the
eagerness to raise rates while inflation is still below target?

I don’t know about you, but I feel that I’m having an Aha! moment here. Oh, and raising rates is still a terrible idea.